Consider the Hidden Costs of Changing Labor Rates

Many types of businesses pay wages at (or near) the minimum hourly level, including retailers, restaurants, home builders, delivery services and beauty salons. So an increase in the minimum wage rate affects many individuals and businesses in some way — and it is currently the source of heated political debates. In this article, we discuss what business owners need to know to make informed decisions about the hourly wages they offer employees.

At the end of this article is a brief discussion of the presidential memorandum to revise the overtime regulations. The revised regs — which could take months to finalize — will also increase costs, but they will affect different classifications of employees than a minimum wage hike.

State Laws Vary

Just like the cost of living, wages vary depending on a worker’s geographic location. The federal government sets the nationwide minimum wage level of $7.25 per hour, with some state and municipalities mandating higher (or lower) minimum wage levels.

States have limited say-so in setting the minimum hourly wage rate. In those states where the state minimum wage is higher than the federal minimum wage, the state minimum wage prevails. However, the federal minimum wage law supersedes state minimum wage laws where the federal minimum wage is greater than the state minimum wage.

Here’s the lowdown on the states with the highest minimum wage rates:

Washington

$9.32/hour

Oregon

$9.10/hour

Vermont

$8.73/hour

Connecticut

$8.70/hour

Illinois, New Jersey, Nevada, and Washington, D.C.

$8.25/hour

— Source: U.S. Department of Labor

Ten states link their minimum wage laws to a consumer price index. So, the minimum wage rates in these states usually increase each year. Three other states — Connecticut, New York, and Rhode Island — voted to increase their minimum hourly wage rates on January 1, 2014.

California’s minimum wage rate will increase from $8.00 per hour to $9.00 per hour on July 1, 2014. Several additional states — including Massachusetts — are currently considering legislation to increase their minimum wage rates in 2014 and beyond.

Current Minimum Wage Stats

The federal minimum wage has been $7.25 since 2009. Over the last five years, the federal minimum wage rate has lost 5.8 percent of its purchasing power to inflation, according to Pew Research Center, a nonpartisan fact tank.

Most states have set minimum wage rates at or above this level. For a full-time employee, the federal minimum wage equates to just $14,500 annually — about half the poverty line for a family of four, which is currently $23,850.

In his State of the Union Address, President Obama endorsed a plan to raise the hourly minimum wage to $10.10 per hour by 2016. By comparison, this increased pay rate equates to $20,200 annually. However, Congress has blocked most of the President’s initiatives in this area.

Note: The federal minimum wage for tipped workers is $2.13 cents per hour and hasn’t changed since 1991.

More Than Direct Labor Costs

When annualized, the proposed increase in the federal minimum wage hardly seems extravagant. Many employers — including retailers like CostCo and Gap — have already agreed to voluntarily increase hourly wages. But there are several hidden costs to consider before you decide to follow suit:

Payroll Tax Increase. A wage hike increases taxes. The more you pay workers, the more you’ll pay in Social Security, Medicare and unemployment taxes. A pay raise can also affect disability and workers’ compensation insurance costs. Employers need to budget for all these costs, not just higher wages.

Ripple Effect. If you raise wages for the least experienced workers, hourly employees just above the minimum wage threshold might expect a raise too. An increase in the hourly minimum wage could require you to increase wages for other employees in order to retain quality workers and your existing pay structure.

An Economic Policy Institute (EPI) study released in December 2013 estimates that if the federal minimum wage were increased to $10.10 per hour, a total of 27.8 million American workers would experience a pay increase through 2016. Of these, 16.7 million people would be workers who are paid at or below minimum wage. The remaining 11.1 million would benefit indirectly because the minimum wage increase would spill over to higher wage brackets.

Shutdowns and Supply Costs. Many small businesses are already struggling to make ends meet in an uncertain economy. Those verging on bankruptcy could shut down if forced to pay higher wages. If an employer closes its doors, its workers will have to find new jobs.

Other businesses will likely increase prices to survive. If everyone along the supply chain gives hourly employees a raise, it could add more costs from suppliers and vendors that pay hourly wages.

Reduced Demand. If companies increase prices, the law of supply and demand dictates that consumer demand will decrease. In other words, a pay increase could reduce a company’s revenue base, which ultimately lowers its bottom line.

Consider family-owned restaurants. Many struggle to compete with franchises that utilize national advertising campaigns and professionally negotiated supplier contracts provided by their franchisors. A price increase could tip the scales in favor of a franchised competitor, making smaller businesses less competitive. Or, if prices go up, some people might opt to eat at home, rather than dine out, lowering revenues for the entire restaurant sector.

Layoffs. Another strategy businesses may employ to balance wage increases is to reduce the size of their workforce. This can be costly over the long run, however. Layoffs can lower morale, as well as put undue pressure on the remaining employees to work harder and faster. Overworked employees may become resentful or call in sick more often.

Higher hourly wages can also make automated equipment a more attractive investment. In addition to replacing low-wage employees with higher skilled, more productive co-workers, some hourly employees — including cashiers and assemblers — could be replaced by touchscreens and robots if wages increase.

The CBO Weighs In

The Congressional Budget Office (CBO), a nonpartisan research agency, released a report in February that predicts that raising the minimum wage to $10.10 per hour would lift approximately 900,000 families out of poverty. On the flip side, the CBO also estimates that the wage-hike could cost about 500,000 jobs by 2016.

The CBO predicts that, if the minimum wages increased to $9.00 per hour, only about 300,000 families would rise above the poverty level and 100,000 workers would lose their jobs. However, the agency admits that the economic consequences of increasing the minimum wage can be hard to predict.

It’s Your Choice: Know the Facts

There are many valid reasons to support a wage increase including fewer Americans living below the poverty line, enhanced buying power for hourly workers, lower turnover and greater job satisfaction. In fact, Gallup polls show that more than three-quarters of Americans support a minimum wage increase.

Before you jump on the wage-hike bandwagon, however, learn about all the possible costs, so you can make an informed decision. Budgeting for an hourly wage increase is complicated and goes beyond simply increasing direct labor expenses. Contact your accounting and payroll professionals for more information.

Changes to Labor Laws Already in the Works

President Obama is serious about bridging the wage gap between the poorest and wealthiest Americans. In March, he signed a presidential memorandum, charging the U.S. Department of Labor (DOL) with revising the federal overtime regulations. This memorandum didn’t specify what the new rules would entail, so stay tuned for more details.

Different Employees Targeted

These changes will affect a different classification of workers than an increase in the minimum wage would. Instead of targeting the lowest paid front line workers — who probably already qualify for overtime pay if they work more than 40 hours — the revised overtime regulations could reduce the number of salaried employees who qualify for “white collar” exemptions and increase the minimum salary threshold for those exemptions, which is currently set at $455 per week on a salary basis. The revised regulations have the potential to impact millions of employees and employers.

Here’s an example of how changing the exemption status of an “assistant manager” would increase a retailer’s direct labor costs. Suppose the assistant manager currently receives $455 per week on a salary basis, which equates to an hourly rate of $11.38 per hour. If he or she works an average of 50 hours per week and becomes eligible for overtime pay at time and one-half his or her regular pay rate under the revised overtime regulations, the employer would pay an extra $170.70 per week. That’s $8,535 or about 38 percent more per year.

Broad Implications

Similar to an increase in the minimum wage rate, changes in the overtime regulations will affect more than just direct labor costs. These changes could also increase payroll taxes and supply costs, reduce demand for the employer’s products and services, cause layoffs, and possibly force some struggling companies out of business.

The increases also could extend beyond workers hovering near the current minimum salary threshold of $455 per week. That’s because the DOL is expected to increase this threshold. But just how high will the DOL go? It’s hard to predict with certainty, but President Obama noted that if the threshold were adjusted for inflation, it would be $561, an increase of 23 percent more.

California’s exemption threshold — double the state’s minimum wage — could also serve as a model for increasing the federal minimum salary threshold. California’s formula would set the new minimum weekly threshold rate at $580 ($7.25 times 2 times 40 hours).

Overtime Won’t Increase Overnight

Although President Obama wants the DOL to move quickly, it’s unlikely that any new regulations would go into effect before the end of 2014. When President Bush issued his presidential memorandum to increase the weekly minimum salary requirement from $155 to $455 in 2004, the process took about two years to complete. It requires the DOL to issue draft proposals, provide a comment period, consider revisions and obtain final approval by the Office of Management and Budget.

So, you still have time to plan your overtime strategy. Discuss with your accountant ways to comply with the changing regulations that balance your cost increases with maintaining a satisfied, productive staff.